Are the Worst of Times Yet to Come?

October 14, 2014

“I plan on using this recording a few years from now as marketing material,” said Rick, speaking to current clients and friends of Sprott Global Resource Investments Ltd., the firm he founded in 1994. “What I’m going to talk about today I think will seem like a prescient market call three or four years from now.”

His recent update was about putting the ‘carnage’ and heavy damage to people’s natural resources portfolio over the last two years, and acutely in the last couple of weeks, in perspective.

“It’s times like these that you’ll look back on as the ‘good old days,’” Rick suggests. “In 2017 or 2018, I believe we will think of 2014 as the days when you could buy companies with the most compelling projects and management teams at 75 percent discounts from their previous highs. ‘Back then, we could see a company fall 30 percent after they refused to take money from us in a private placement, and we could buy the stock at even more attractive terms,’ we’ll say.

“We have all had the experience of seeing goods on sale and procrastinating, and later on seeing them priced much higher. You think to yourself ‘I really wish I’d participated.’ Those are the kinds of times that get referred to as ‘the good old days.’”

Right now, it feels like we couldn’t be done with good old days soon enough. As Rick puts it, “You are either a contrarian or a victim, I’ve often said. Sometimes, it’s possible to be both.” Right now certainly feels like one of those times.

That’s no reason to give up on your contrarian investments, according to Rick. If you were correct in your initial assessment, and the goods you bought were indeed ‘on sale,’ then the right thing to do is to hang on.

As Rick explains, this is what made his fortune during the last period of ‘good old days’ for the resource sector – the profound bear market of the 1998 to 2001 period. He checked his reasoning for investing in the companies he owned, and decided he’d made the right choice.

Rick tells the story: “Companies in the resource sector were in a once-in-a-decade sale at the end of the 90’s. There was one commodity in particular, uranium, which had been in a 20-year bear market. The price had gone from 32 dollars to 8 dollars a pound. Not only did people lose money, but, to make things worse, it was a despised material. It was perceived as having cost people their lives at Hiroshima, Nagasaki, or Three Mile Island. The commodity had underperformed so bad that the margins on producing it were now negative.

“There was one Australian company at the time, called Paladin, which owned a uranium mine. The bear market for resources was even more severe in Australia than it was in Canada.

“In 1998, I realized that uranium was a spectacular contrarian investment. Nuclear power made up 16% of the world’s energy. As long as the Western world continued to want to have electricity, the price would have to go up, or the lights would go out. I had decided that Paladin was a highly speculative bet on that outcome.

“I financed them at 10 cents, and the stock rose a little. I financed them again at 12 cents. Then, things got ugly. The price went to 11 cents, then 9, then 8. A crisis of confidence had occurred among shareholders. The stock went all the way to 1 penny. That’s the kind of situation where you have to re-examine your premises. Was there something wrong with Paladin’s asset? Or was it my thesis that uranium would get more expensive that was wrong?

“I decided that my premises were accurate. The world consumed 160 million pounds of uranium, and it only produced around 80 million pounds. There was a standing supply of around 400 million in the way of a shortage. The deficit was getting worse because of low uranium prices. I also figured that Paladin’s deposit would not make money at 8 dollars a pound, but could make money at 25 dollars per pound.

“I got the courage to stay with the trade, partly thanks to George Soros’ comments that his fortune was made by finding commonly held perceptions that were false and betting against them.1 He had pulled 4 billion dollars out of a trade where he found that the perception that the bank of England could keep the Sterling strong was false. I decided that I was in good company with my bet on Paladin. My only enemy was time. I had to remain solvent, and make sure that Paladin remained solvent too.

“A few years later, my courage was rewarded. Shares went to 10 dollars a share from 1 cent. The stock added three zeros2. That was the single most important financial event of my career. I’m not saying that the resource market will add three zeros from here, but when you think about the ‘good old days’ of 1998 to 2000, you’ll find they have a lot in common with today’s predicament.

“The stock market was zooming higher, especially technology stocks. Debt markets were on fire with decreasing interest rates, and resources were cheap. Does any of that sound familiar?”

Listening to this, I thought – ‘well there are some differences.’ First off, there was no QE in 2000. I’m not sure how that changes things; for all we know, QE and low interest rates fundamentally change the game. We’re also in a situation where corporations are making record profits despite a poor economy. In 2000, the economy was arguably in a real boom phase, but corporate profits were lower. Perhaps Rick will address these questions on a future call. For now, let’s go back to his premise on gold.

“Now is the time to re-examine our premises on gold. Let’s look at how gold compares to US Treasuries, which compete with gold for savings worldwide. I’m not advocating that you switch all of your dollars to gold, but given that gold currently represents around 0.25% of investment portfolios, there is room for more gold in most people’s portfolios. The 10-year US Treasury currently yields between 2.5 and 2.6 percent. Those bonds are guaranteed by taxation and the Fed’s ability to print. On its face, that yield comes when CPI inflation is around 2.5 percent. That’s what Jim Grant famously calls ‘return-free risk.’ More reliable numbers suggest your cost of living increases by around 5 to 6 percent a year. In other words, you put in 100,000 and you get back 60,000 in purchasing power after 10 years.

“Besides this, there’s the fact that the US currently has around 70 to 80 trillion off-balance-sheet liabilities3. Does anyone believe that they have the ability to service these obligations? These numbers, by the way, could become a lot worse once the full costs of Obamacare are determined and factored into Social Security and Medicaid.”

In other words, according to Rick, buy gold and precious metals as insurance against risks to your US Treasuries and US dollars.

On the other hand, buy commodities if you believe in a long-term trend of population expansion in the world and greater worldwide GDP:

“If you believe in the thesis that world GDP will continue to expand and that population growth will continue, then you should own natural resources. New people who are born will want to eat, drive, and build houses. This trend offers long-term support for natural resources.”

Rick warns that there are still risks to owning natural resource companies now - technical analysts tell us to watch out for a ‘triple-bottom’ in gold. If that happens – and we’ve had two bottoms, in July and December of 2013 – then watch out below, says Rick.

“In the near term, the efficient market is a sham, because sentiment outweighs fundamentals. We are approaching a potential capitulation sell-off. I don’t know whether that will happen or not. If it does, it will terrify all investors in the sector – including me. It would be akin to the summer of 2000, where investors simply ‘gave up the ghost.’ If it doesn’t happen, then expect to continue a gradual, ‘saucer-shaped’ recovery.”

The good news?  Rick doesn’t expect the ‘good old days’ to last forever. “I’m not talking 5 to 10 years to be right. I’m talking 2, 3, or maybe 4 years down the road. I believe we will be talking about these as the ‘good old days,’ and I look forward to sharing those memories with you.”


P.S.: Want to hear more from Rick Rule, Eric Sprott, and other members of the Sprott team? Subscribe to our free e-letter, Sprott’s Thoughts.

1 The Alchemy of Markets: Reading the Mind of the Market, by George Soros. Wiley & Sons Inc. 1987, 1994

2 Bloomberg online stock charts: Paladin Energy Ltd.

3 The Wall Street Journal online: Cox and Archer: Why $16 Trillion Only Hints at the True U.S. Debt. November 28, 2012.

The melting point for silver is 961.93 °C - 1235.08 °K

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